Chapter 24: Capital Budgeting

Flashcards covering key concepts in Chapter 24 on Capital Budgeting.

The process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

Capital budgeting

This group evaluates investment proposals and recommends approval or rejection.

Capital budget committee

These decisions are considered most difficult and risky due to uncertain outcomes, large sums of money, long-term commitment, and potential irreversibility.

Capital budgeting decisions

The formula: Initial investment / Annual net cash flow, is used for calculating this.

Payback period

Its strengths include using cash flows and being easy to compute.

Payback period

A significant weakness is that it ignores cash flows after the payback period and does not account for the time value of money.

Payback period

An investment's annual income divided by the average amount invested in it.

Accounting rate of return (ARR)

The decision rule for selecting investments: choose the one with the highest rate.

Accounting rate of return (ARR)

The required ARR, which is the cost of capital, reflecting the rate the company must pay to its lenders and investors.

Hurdle rate

It applies the time value of money to future cash inflows and outflows to evaluate a project's desirability.

Net present value (NPV)

Calculated by discounting future net cash flows at the required rate of return and subtracting the initial investment.

Net present value (NPV)

The decision made when expected net cash flows yield a positive NPV.

Invest in the project

A method used to rank projects of similar initial investment amounts and risk levels.

Profitability index

A measure of the expected time until the present value of the net cash flows from an investment equals the initial investment.

Break-even time (BET)

It stands for Internal Rate of Return and is compared to the predetermined hurdle rate to decide on investments.

IRR

A series of cash flows of equal amounts.

Annuity

The concept stating that a sum of money is worth more now than the same sum will be at a future date due to its potential earning capacity.

Time value of money

The rate of return that a company must earn on an investment to maintain its market value and attract new financing, often synonymous with the hurdle rate.

Cost of capital

Investments typically involving large sums of money and having benefits that extend over several years, making them a focus of capital budgeting.

Long-term investments